RATE OF RETURN AND REMAINING MINE LIFE
2019-2024
Final Report July 2019 RATE OF RETURN AND REMAINING MINE LIFE from 1 July 2019
IPART HAS DETERMINED THE RATE OF RETURN AND ESTIMATED THE REMAINING MINE LIFE APPLYING UNDER THE NSW RAIL ACCESS UNDERTAKING FOR FIVE YEARS FROM 1 JULY 2019
The rate of return applies to all networks under the NSW Rail Access Undertaking
Country Regional Sydney Metropolitan ARTC's non-Hunter RailCorp's Hunter Network Freight Network Valley network Valley Coal Network
The remaining mine life is used to detemine depreciation for RailCorp's Hunter Valley Coal Network from Woodville to Newstan Junction
Our review process
Nov Apr Jul 2018 2019 2019
Fact Sheet Draft Report Final Report Submissions closed: 28 May 2019 RATE OF RETURN AND REMAINING MINE LIFE from 1 July 2019
Our final decisions A 5.3% pa real, RailCorp's HVCN sectors transport coal for many purposes, but the most significant is supplying the Eraring and Vales post-tax rate of Point power stations. These are likely to operate until at least return will apply 2032 when Origin Energy (owner of Eraring) has announced it will exit coal-fired generation. from 1 July 2019 Their future beyond then depends on a number of variables, including current and likely government policies on energy and climate change. On balance, we consider that basing our remaining mine life estimate on a terminal date of 2040 reduces RailCorp's risk of asset stranding, while mitigating customer price impacts.
Our final decision on the rate of return is made in accordance with our standard approach to calculating the weighted average cost of capital (WACC) for a regulated business. This aims to provide regulatory certainty and a buffer against short-term fluctuations in the market. The WACC takes Our estimated remaining into account recent evidence on industry- specific parameters, including an equity beta mine life is 21 years, based of 1.0 and benchmark gearing of 45%. on a terminal date of 2040
The NSW Government should ask IPART to undertake a review of the NSW Rail Access Undertaking
Since the Undertaking came into effect in 1999, there have been significant changes to the ownership, scope and complexity of the regime and it is no longer meeting the needs of stakeholders.
We propose to improve Many issues arise from transparency of our inconsistency and overlap We would compliance reporting to between rail access regimes support a to make it easier for end that would not be addressed by our review. We have written national review users and rail operators of rail access to work out what they to the Productivity Commission are owed. to recommend a national regimes review of rail access regulation. RATE OF RETURN AND REMAINING MINE LIFE from 1 July 2019
How this report is structured
Chapter 1 sets out the context and scope for our review. Chapter 2 discusses our analysis and final decision on the rate of return. Chapter 3 discusses our analysis and final decision on the estimated remaining mine life of the relevant Hunter Valley mines utilising the rail sectors. Chapter 4 discusses our analysis and recommendations about rail access regulation.
Contents
1 Review context and scope 1 1.1 IPART’s role in determining rate of return and depreciation 2 1.2 Which rail networks are covered by this review? 4 1.3 Previous decisions on the rate of return and estimates of the remaining mine life 4 2 Determining the rate of return 6 2.1 Final decision on the rate of return 6 2.2 Our approach to estimating WACC parameters 8 3 Estimating the remaining mine life 14 3.1 Final decision on estimated remaining mine life 14 3.2 Our approach to estimating remaining mine life 14 4 Reviewing the rail access regime 27 4.1 We recommend a review of the NSW access regime 27 4.2 The NSW Rail Access Undertaking is not meeting the needs of stakeholders 28 4.3 We will provide more information in our compliance reports 31 A Proxy company selection and beta estimation 34 B Mine reserves and production sources 36 C Copyright for this report 38
The Tribunal Members for this review
Dr Paul Paterson, Chair Mr Ed Willett The Independent Pricing and Regulatory Ms Deborah Cope Tribunal (IPART) provides independent regulatory decisions and advice to protect and promote the ongoing interests of the Enquiries to this review should be directed to a staff member: consumers, taxpayers and citizens of NSW. Melanie Mitchell (02) 9113 7743 IPART’s independence is underpinned by an Rate of return andIneke remaining Ogilvy (02) mine 9290 8473life IPART iv Act of Parliament.
1 Review context and scope
Under Schedule 6AA of the Transport Administration Act 1988, the NSW Rail Access Undertaking (the Undertaking) provides for third party access to the rail network in NSW, including specifying certain pricing principles that rail owners must apply in negotiating access prices.
The Undertaking requires IPART to assess the annual compliance of rail owners with these provisions, and also review, every five years, the rate of return and depreciation that rail owners must apply when setting maximum prices.
This chapter discusses IPART’s role under the Undertaking, the network covered by our review and our previous decisions. It also discusses our reasons for recommending an independent review of the NSW rail access regime.
Rate of return and remaining mine life IPART 1
1.1 IPART’s role in determining rate of return and depreciation
Schedule 3 of the Undertaking sets out the pricing principles that rail infrastructure owners must apply in negotiating access prices. These principles require prices to include both a return on capital and depreciation of rail assets.
The pricing principles sets out a process that each rail infrastructure owner must follow to estimate the value of their assets in each year (the asset valuation roll forward principles). In doing this, the Undertaking requires them to use: For all networks covered by the Undertaking, the rate of return determined by IPART For the Hunter Valley Coal Network (HVCN) only, depreciation calculated using the useful life of rail assets, estimated by IPART.
We determine the We are required to review and revise these every five years. We are required rate of return and to estimate the useful life of the HVCN sectors with reference to the estimated estimate remaining remaining mine life of the coal mines that use them. mine life every five Specifically, schedule 3, clause 2.1 states that the: years Rate of return means a rate of return in percentage terms approved by IPART for a period of five years to be applied to the average of the Opening and Closing Regulatory Asset Base.
Schedule 3, clause 3.2(c)(i) and (ii) of the Undertaking state that: (i) depreciation is to be calculated at the beginning of each financial year using a straight-line methodology and the estimate of the remaining useful life of the assets (ii) the useful life of a Sector or group of Sectors is to be determined by reference to the remaining mine life of the Hunter Valley coal mines utilising that Sector or those Sectors.
As well as revising these elements every five years, we are also responsible for assessing compliance with the Undertaking, including ensuring that the correct rate of return and depreciation have been used (see Box 1.1).
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Box 1.1 Assessing compliance with the Undertaking
We assess compliance against the requirements of Schedule 3 of the Undertaking annually. The compliance obligations on rail infrastructure owners differ depending on whether the network is part of the HVCN and how much access revenue is received relative to the cost of providing services.
RailCorp’s HVCN is the only part of the HVCN that is currently subject to the NSW Rail Access Undertaking. For these sectors, we review compliance under Schedule 3, section 5(b) of the Undertaking, which involves determining RailCorp’s compliance with both Asset Valuation Roll Forward Principles (including return of and on capital) and the Ceiling Testa, having regard to the operation of an ‘Unders and Overs’ account. The HVCN is subject to greater monitoring as it is more likely, given the volumes of coal traffic, to potentially over- We assess recover costs. compliance with For non-HVCN rail networks, we review compliance under Schedule 3, section the Undertaking 5(f) of the Undertaking. Essentially, this requires the rail infrastructure owners, annually RailCorp and the ARTC, to demonstrate to our reasonable satisfaction that access revenue is not more than 80% of the full economic cost of providing access under the Ceiling Test for any group of access seekers.
Rail infrastructure owners must submit documents demonstrating compliance with the Undertaking over the past financial year by 31 October each year.
Our five yearly revisions of the rate of return and remaining mine life form the basis for the return on capital for all networks and depreciation for the HVCN. a For any access seeker or group of access seekers, access revenue must not exceed the full economic costs of the sectors which are required on a standalone basis for the access seeker or group of access seekers.
1.1.1 Are there other legislative factors IPART needs to consider?
In its submission to our Draft Report, The Australia Institute submitted that IPART must have regard to provisions in section 15 of the Independent Pricing and Regulatory Tribunal Act 1992 (IPART Act), and hence, The Protection of the Environment Administration Act 1991.1
Among other things, section 15 of the IPART Act requires us to take into account the need to maintain ecologically sustainable development and the social impact of its recommendations and determinations. However, it requires us to have regard to those matters only in ‘making determinations and recommendations’ under the IPART Act.2 It does not apply to this review, which we are conducting under the NSW Rail Access Undertaking, not the IPART Act.
However, as discussed in Chapter 3, we have taken into account relevant government and company policies on energy and environmental matters that are likely to impact our estimate of the remaining life of relevant coal mines.
1 The Australia Institute submission to IPART Draft Report, June 2019, p 4. 2 Independent Pricing and Regulatory Tribunal Act 1992, Section 15(1).
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1.2 Which rail networks are covered by this review?
Our final decision on the rate of return applies to each of the networks covered by the Undertaking. However, the estimated remaining mine life applies only to the five sectors of the HVCN covered by the Undertaking.
The Undertaking currently covers all or part of four rail networks across NSW including the Country Rail Network (CRN), the Sydney Metropolitan Freight Network (MFN), ARTC’s non-HVCN sectors and the five sectors of the HVCN owned by RailCorp.
The HVCN comprises 37 track sectors of which 32 are leased to the ARTC for 60 years from 5 September 2004.3 The ARTC has a separate undertaking with the Australian Competition and Consumer Commission (ACCC) (Hunter Valley Access Undertaking 2011 (HVAU))4 and these sectors are regulated under the national regime.
RailCorp owns the remaining five sectors of 21 route kilometres running between Newstan and Woodville Junction (Table 1.1 below). They are used by passenger trains as well as coal and other freight trains.
Table 1.1 RailCorp Hunter Valley Coal Network list of sectors The rate of return applies to each Sector Name Route kilometres network covered by 405 Newstan Jct to Cockle Creek 7.18 the Undertaking. 406 Cockle Creek to Sulphide Jct 3.15 The estimated 490 Sulphide Jct to Adamstown 8.05 remaining mine life 407 Adamstown to Broadmeadow (via Main) 1.60 applies only to 497 Broadmeadow to Woodville Jct 0.85 RailCorp’s sectors Source: NSW Rail Access Undertaking, Schedule 6 of the Hunter Valley Coal Network 1.3 Previous decisions on the rate of return and estimates of the remaining mine life
We set the initial estimate of remaining mine life for all 37 sectors of the HVCN at 40 years from 1 July 1999, giving a terminal date of 2039. This was based on: The estimated rail infrastructure asset life, which was 39.4 years5 A balance between stakeholder views, which ranged from 30 to 50 years.6
3 https://www.artc.com.au/projects/hv-strategy/, accessed 2 July 2019. 4 https://www.accc.gov.au/regulated-infrastructure/rail/artc-hunter-valley-access- undertaking, accessed 2 July 2019. 5 IPART, Aspects of the NSW Rail Access Regime – Final Report, April 1999, p 44. 6 Ibid, p 45.
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In subsequent reviews, we identified the mines using the track, determined the amount of coal available and the amount likely to be extracted each year, depending on infrastructure capacity and market conditions.
At the time of our 2014 review, the ARTC HVCN sectors no longer fell under the Undertaking, which changed the configuration of coal mines under consideration. Further, the two mines located on the remaining section of track, Newstan and Teralba, were no longer operational and so were not using the line to export coal from Newcastle. However, we determined that while the two power stations south of the line – Eraring and Vales Point – remained operational, there would be potential demand for coal from Hunter Valley mines, as long as the mines could supply it.7 We found that the median terminal date of the subset of longest-lived substantial mines was 2044.8 We engaged Frontier Economics to advise on the likely economic lives of the power stations, given various energy scenarios. Frontier considered that 2044 was a reasonable estimate of the economic lives.9 As such, we extended its estimate of the remaining mine life by five years from the initial terminal date of 2039 to 2044.10
At our 2014 review, we also moved from a pre-tax to a post-tax WACC, following an IPART-wide change in our WACC method.11
Table 1.2 shows IPARTs previous decisions on the rate of return and estimated remaining mine life since the initial Undertaking in 1999.
Table 1.2 Previous IPART decisions
Decision Remaining mine life Rate of return Initial Undertaking (1999) 40 years (to 2039) real pre-tax WACC 8.0% 2004 35 years (to 2039) real pre-tax WACC 7.3% 2009 30 years (to 2039) real pre-tax WACC 8.0% 2014 30 years (to 2044) real post-tax WACC 5.9% Source: IPART, Aspects of the NSW Rail Access Regime, Final Report, April 1999; IPART, Report on the determination of remaining mine life and rate of return from 1 July 2004, May 2005; IPART, NSW Rail access undertaking – review of the rate of return and remaining mine life from 1 July 2009, Final report and decision, August 2009; IPART, NSW Rail access undertaking – review of the rate of return and remaining mine life from 1 July 2014, Final report and decision, July 2014.
7 IPART, NSW Rail Access Undertaking – Review of the rate of return and remaining mine life – Final Report, July 2014, p 2. 8 Ibid, p 27. 9 Ibid, pp 31-32. 10 Ibid, p 2. 11 Ibid, p 12.
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2 Determining the rate of return
We aim to provide the operator of the rail network with an estimated rate of return equivalent to that required by the market to invest in those assets. We use this rate of return to calculate the full economic cost of a group of line sectors for the ceiling test.
Since our 2014 review, we have used a real post-tax WACC to estimate the rate of return, and a standard method for determining most market-based parameters.12 We conduct our own analysis to determine industry-based parameters such as equity beta and gearing.
This chapter outlines our final decision and explains how we have applied our standard method to calculate the WACC. It explains our analysis on the appropriate equity beta and gearing that should apply to the networks under the Undertaking.
2.1 Final decision on the rate of return
Final Decision 1 That the rate of return that should apply from 1 July 2019 is 5.3% per annum on a real, post-tax basis.
This is the mid-point of the upper and lower bounds of the range calculated using long-term averages and current market data. Table 2.1 shows the parameters used in our WACC decision.
This is 60 basis points lower than the rate of return that applied from 1 July 2014 of 5.9% per annum on a real, post-tax basis.
It is 50 basis points lower than our draft WACC of 5.8% per annum. The main driver of this difference is a 90 basis point drop in the current risk-free rate, which also contributed to a 60 basis point drop in the current cost of equity.
12 IPART, NSW Rail Access Undertaking – Review of the rate of return and remaining mine life – Final Report, July 2014, p 12
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Table 2.1 Final decision on WACC
Step 1 – Current and long-term estimates Step 2 – WACC range Current Long- Lower Mid- Upper market term point data averages Nominal risk-free ratea 1.8% 3.4% Inflation 2.4% 2.4% Implied debt margin 2.3% 2.6%
Market risk premium 8.9% 6.0% Debt funding 45% 45% Equity funding 55% 55% Total funding (D + E) 100% 100% We adopted a Gamma 0.25 0.25 WACC of 5.3% on a Corporate tax rate 30% 30% real, post-tax basis Effective tax rate equity 30% 30% Effective tax rate debt 30% 30% Equity beta 1.00 1.00
Cost of equity (nominal post-tax) 10.7% 9.4% Cost of equity (real post-tax) 8.1% 6.8%
Cost of debt (nominal pre-tax)a 4.1% 6.0% Cost of debt (real pre-tax) 1.7% 3.5%
Nominal Vanilla (Post-tax nominal) 7.7% 7.9% 7.7% 7.8% 7.9% WACC Post-tax real WACC 5.2% 5.3% 5.2% 5.3% 5.3% Pre-tax nominal WACC 9.4% 9.4% 9.4% 9.4% 9.4% Pre-tax real WACC point estimate 6.9% 6.8% 6.8% 6.8% 6.9% a We have corrected a calculation error with the cost of debt that we made in our Draft Report. Our draft decision on the nominal, pre-tax cost of debt should have been 4.8%, rather than 5.0%, and the nominal risk-free rate should have been 2.4%, rather than 2.7%. Source: Bloomberg; IPART analysis.
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2.2 Our approach to estimating WACC parameters
Consistent with the requirements of the Undertaking, we estimated a single rate of return, which would apply to the average of the opening and closing RAB for the five year period from 1 July 2019.
We estimated the industry parameters - equity beta and gearing - using a proxy company analysis. To determine the appropriate market parameters, we applied our standard 2018 WACC method. For our final decision, we used the following sampling dates to determine our current market parameters: For the current year, the sampling period ending 31 May 2019, which is the last available whole month. For other years, the sampling period ending 31 May, although consistent with our decision to use a single cost of debt, we assume that the whole of the current debt would be refinanced at the rates applying at the end of May 2019.
We used a proxy This assumes that RailCorp would refinance its entire current debt at the rates company analysis applying at the end of May 2019.13 to estimate industry In its submission, the ARTC supported our draft rate of return and our parameters approach in balancing long-term and spot market rates to remove volatility in rate determinations and provide greater temporal stability.14 However, it suggested further improvements to our WACC method via the addition of forward expectations into the formula, noting that in the absence of a future expectations model, the IPART approach is the next most optimal formula.15
In 2018, we reviewed our WACC method, taking into account a wide range of stakeholder views, including those of the ARTC. We decided that our method of using a default 50-50 weighting between the current and long-term estimates of the cost of debt and equity to estimate the WACC provided the most appropriate balance between forecasting future market conditions, while accounting for short-term market cycles to provide greater stability in regulatory returns.16
2.2.1 We have used an equity beta of 1.0 and gearing of 45%
The systematic risk of an asset is measured by its ‘beta’ factor. The beta reflects the extent to which future returns are expected to co-vary with the overall market. Gearing represents the amount of debt capital in a firm’s
13 Our 2018 WACC method introduced a decision to estimate both the long-term and current cost of debt using a trailing average approach, which updates the cost of debt annually over the regulatory period. However, this is inconsistent with the provisions of the Undertaking, which allow only for a single cost of debt for a five year period. 14 ARTC submission to IPART Draft Report, May 2019, pp 1-2. 15 Ibid. 16 IPART, Review of our WACC method, February 2018, p 3.
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capital structure. Where the business risk of a firm is high, it is expected that the firm will carry less debt and vice versa.
In our Draft Report, to estimate the equity beta and gearing for the rail networks covered by the Undertaking, we: 1. Compiled a list of comparable transport infrastructure companies using publicly available information from the Thomson Reuters Datastream 2. De-levered each company’s equity beta to generate an asset beta, and re-levered the asset beta using the benchmark company’s gearing ratio and corporate tax rate 3. Calculated the median, re-levered equity beta and gearing level for the sample 4. Compared the result to equity betas for other industries, and those determined by other regulators.17 We adopted an equity beta of 1.0 Appendix A explains our process for the first three steps in more detail. and gearing ratio of We examined a range of comparator firms and found that the median 45% based on a equity beta was 1.0 sample of proxy In selecting proxy industries, we consider the type of business the firm is in. companies If we can’t directly identify proxy firms that are in the same business, then we consider which other industries exhibit returns that are comparably sensitive to market returns.
There are only a few listed pure-play freight rail infrastructure firms as far as we know. For the Draft Report, we used a relatively narrow set of firms (10 firms) that we considered had a high degree of comparability to RailCorp and ARTC’s regulated businesses.18 Those firms were mainly US and Canadian Class 1 railroad operators. While RailCorp’s HVCN does not compete with road transport, other networks under the Undertaking, such as the CRN and MFN transport freight other than coal that competes with road transport and would face greater exposure to market risk, similar to the Class 1 railroad operators.
17 IPART, NSW Rail Access Undertaking – Review of the rate of return and remaining mine life, Draft Report, April 2019, pp 9-10. 18 Ibid, p 10.
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Table 2.2 shows our comparator company analysis.
Table 2.2 Summary of beta estimation results
Name Listed Levered Unlevered Relevered Gearing Exchange beta asset beta beta Genesee & US 1.5 1.1 1.7 36 Wyoming 'A' Norfolk US 1.4 0.9 1.4 42 Southern Canadian US 1.0 0.8 1.2 31 National Railway PKP Cargo Poland 1.0 0.7 1.2 34 CSX US 1.3 0.7 1.1 54 Kansas City US 0.9 0.6 1.0 34 Southern Canadian US 1.1 0.6 0.9 57 Pacific Railway Union Pacific US 1.0 0.6 0.9 52 Getlink France 1.2 0.5 0.8 68 Aurizon Australia 0.6 0.4 0.6 44 Holdings Median 0.66 1.0 43 Source: Thomson Reuters Datastream and IPART analysis.
We received no submissions on the selection of comparator companies. However, Pacific National submitted that the 5.8% rate of return in our Draft Report was likely to be excessive, noting that our implied equity beta was higher than the ACCC and QCA allowed.19 Having reviewed those decisions (discussed in more detail in the next section), we found that they are based on using a broader sample of comparator firms, which we consider are not wholly representative of the risk profile of the networks under the Undertaking.
An equity beta of 1.0 is consistent with other regulator’s findings, taking into account the risk profile of comparable industries
In our Draft Report, we considered other regulators’ recent assessments of the gearing and systematic risk faced by comparable rail businesses (see Table 2.3).
19 Pacific National, Submission to IPART Draft Report, May 2019, p 2.
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Table 2.3 Other regulatory decisions on equity beta and gearing
Organisation Regulator Gearing Equity Asset beta beta ARTC Interstate Undertaking ACCC 50% 1.2 0.6 (2017 – withdrawn) ARTC HVAU (2017) ACCC 52.5% 0.94 0.45 Queensland Rail (2016) QCA 55% 0.8 0.45 Arc Infrastructure (2017) ERA 25% 0.9 0.7 Aurizon (2017) QCA 55% 0.73 0.42 Public Transport Authority (2017) ERA 50% 0.6 0.3 Source: Source: ERA, Determination on the 2017 Weighted Average Cost of Capital for the Freight and Urban Railway Networks, and or Pilbara railways, 2017; ACCC, Australian Rail Track Corporation’s 2018 Interstate Access Undertaking, December 2018; QCA, Aurizon Network's 2017 draft access undertaking, December 2018; QCA, Queensland Rail's Draft Access Undertaking, June 2016.
The QCA’s most recent WACC decision adopted an asset beta of 0.42 and equity beta of 0.73,20 both of which are lower than the beta values we have adopted. While Aurizon’s consultants, the Brattle Group and Frontier Economics, proposed an asset beta of 0.55 to 0.6521 and a higher equity beta22, based on North American pipeline and rail freight transport comparators, the QCA stated that it: …does not consider that North American pipelines or rail freight transportation businesses are appropriate comparators for Aurizon Network. In comparing those relevant characteristics that are expected to affect systematic risk and examining the underlying economic fundamentals, the QCA considers regulated energy and water businesses are comparable firms of similar systematic risk to Aurizon Network at this time.23
The end use of the rail infrastructure that is subject to the Undertaking is a mix of transporting coal either for export or for domestic electricity generation, and grain and general freight to Ports Botany, Kembla and Newcastle. Some of these networks face substantial competition from road freight. On balance, we consider that the rail infrastructure owners’ systematic risk would be more similar to that of a Class 1 railroad operator than a regulated energy and water utility.
Pacific National also submitted that government ownership of RailCorp likely made its returns less risky than private sector peers.24
20 QCA, Aurizon Network’s 2017 draft access undertaking - Appendices, December 2018, p 70. 21 The Brattle Group, Aurizon Network 2016 Access Undertaking, Aspects of the WACC, November 2016, p 3. 22 Frontier Economics, Equity beta, Report prepared for Aurizon Network, November 2016, p 15. 23 QCA, Aurizon Network’s 2017 draft access undertaking - Appendices, December 2018, p 70. 24 Ibid.
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We set the WACC of a benchmark efficient entity, irrespective of its ownership. Whoever owns that entity earns the relevant return. In some cases, a smaller firm is owned by a larger firm.
Analysis of a broader set of comparable firms supports our estimate of an equity beta of 1.0
While we do not propose to adopt the same comparator industries as the ACCC and QCA, we have considered whether the use of a broader set of comparators would lead to a different result.
We considered that three broader proxy industries could include: coal mining, coal-fired electricity generation, and a broader set of rail transport businesses. We found that: Asset beta: Across both time periods, the median asset betas were 0.67 Our analysis of a for coal mining, 0.58 for electricity generation and 0.70 for rail transport. The median of all three industries is an asset beta of 0.64 broader set of comparable firms Gearing: Across both time periods, the median gearing ratios were supports our equity 48% for coal mining, 47% for electricity generation and 38% for rail transport. The median of all three industries is a gearing ratio of 45% beta estimate Equity beta: The resulting median equity betas were 1.1 for coal mining, 0.9 for electricity generation and 1.1 for rail transport. The median of all three industries is an equity beta of 1.0.
Our estimated asset beta is at the top of the range adopted by IPART for other industries
The proposed median asset beta of 0.64 is at the top of the range of asset betas previously adopted by IPART (see Table 2.4).
Table 2.4 Range of asset beta values previously adopted by IPART
Industry Asset beta adopted by IPART Rate of return and remaining mine life (Final Report 2019) 0.64 Cruise terminal 0.60 Private ferries, Sydney ferries 0.45 Rural and regional buses 0.43 Rail access (freight rail) 0.38 Sydney and NSW Trains (passenger rail) 0.36 Light rail 0.35 Valuer General (2014, implied from equity beta and gearing) 0.34 Valuer General (2019 Determination) 0.29 Water industry 0.28 Note: Equity beta values will be higher than these asset betas because they also reflect financial risk. The conversion between the two depends on each firm’s gearing and the prevailing corporate tax rate.
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Source: IPART, Review of prices for land valuation services provided by the Valuer General to councils, Final Report, May 2019, p 73.
However, we note that the asset beta is lower than what we have found previously for the electricity generation (0.74) and retail (0.87) sectors, although we no longer determine prices for electricity.25
25 IPART, Review of regulated retail prices and charges for electricity – Final Report, June 2013, p 204.
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3 Estimating the remaining mine life
The Undertaking requires us to estimate the useful life of a rail sector or group of sectors by reference to the remaining life of Hunter Valley coal mines that use those sectors. It is used as a proxy to calculate depreciation to determine compliance with the ceiling test and roll forward the Regulatory Asset Base (RAB). The Undertaking requires depreciation to be calculated on a straight-line basis.
This chapter sets out our final decision on our estimate of the remaining mine life, explains how we reached our conclusion and the implications for maximum prices. It discusses the current and potential coal traffic flows on the RailCorp HVCN sectors, the longest-lived substantial mines using the sectors, their reserves and output, and what this means for the terminal date.
3.1 Final decision on estimated remaining mine life
Final Decision 2 IPART’s estimate of the remaining mine life from 1 July 2019 is 21 years, based on a terminal date of 2040.
Our estimate is based on an expected terminal date that is four years earlier than the current terminal date of 2044. Using this estimate as the basis for depreciation charges for RailCorp’s HVCN sectors would result in an increase in maximum rail access prices of around 4.4% per annum, all else constant. We consider this an appropriate balance between reducing the risk of asset stranding to the owner and mitigating customer price impacts.
3.2 Our approach to estimating remaining mine life
Our approach is to consider a range of factors that would affect the remaining lives of the mines that use RailCorp’s sectors of the Hunter Valley Coal Network and then to make a judgment on the remaining life of those mines.
The factors we have taken into account include: 1. Current and potential uses of the line to transport coal26 2. Changes to demand for coal-fired electricity generation and the economic lives of the Eraring and Vales Point power stations
26 At our 2014 review, we considered that the relevant mines need not necessarily be located along the sector, but may include any mine with the production capacity to supply the power stations, whether it was currently supplying, or could potentially supply, the power station in the foreseeable future. See IPART, NSW Rail Access Undertaking – Review of the rate of return and remaining mine life - Final Report, July 2014, p 25.
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3. Changes to BlueScope Steel’s demand for Hunter Valley coal 4. The outlook for other coal users of the line 5. The longest-lived substantial mines (LLSM) using the line, their marketable reserves and production levels.
We also considered how the risks of asset stranding have changed since our 2014 review, and the relative price impacts of a change to the terminal date.
In its submission, The Australia Institute stated that our approach: …does not consider the climate change or health impacts caused by the coal transported on the rail networks under their projected operations.27
As noted in Chapter 1, because we are not undertaking this review under section 15 of the IPART Act, we are not required to consider environmental and social factors when setting the rate of return and estimating the remaining mine life. The estimated remaining mine life is used only as a proxy to calculate depreciation for RailCorp’s HVCN assets. Our estimate has no bearing on the actual lives of the power stations or mines. However, in assessing the economic lives of the power stations and future demand for coal in Australia and globally we have had regard to current and likely government policies on energy and climate change.
3.2.1 The line is used to transport coal in both directions and for a range of purposes The line from Woodville to This section of the rail line, subject to our estimate of the remaining mine life, runs south of Newcastle, from Woodville Junction to Newstan. The line is Newstan Junction used to transport coal from the Hunter Valley to the Eraring and Vales Point is used mainly to power stations, to BlueScope Steel and Port Kembla, as well as from south transport coal to and western mines to export at Newcastle. Hunter Valley mines do not use power stations, Port the line to export coal at Newcastle, but they do use the line to transport coal Kembla and the to supply the two power stations at Eraring and Vales Point. Port of Newcastle There are no operational mines located along the track, because Newstan Colliery and Teralba Colliery were placed on ‘care and maintenance’ in 2014 and 2001 respectively. However, Newstan Colliery loop acts as a turnaround point for coal trains destined for the power stations arriving from the south. Newstan Colliery’s facilities are also used for some processing tasks for coal transported from Mandalong.28
Figure 3.1 shows a map of the line segment, including the location of the power stations, Newcastle and Newstan and Teralba mines.
27 The Australia Institute submission to IPART Draft Report, June 2019, p 5. 28 IPART consultation with Centennial Coal, May 2019.
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Figure 3.1 RailCorp’s HVCN rail line showing the location of the power stations and mines
Data source: RailCorp, TOC Operating Conditions Manual version 9.0, April 2017, p 35.
Figure 3.2 shows the annual coal traffic on the line over the last four years.
Figure 3.2 Coal traffic on RailCorp’s HVCN since 2015-16 (gross tonnes per annum)
5,000,000 2015-16 2016-17 2017-18 2018-19 (adj) 4,500,000 4,000,000 3,500,000 3,000,000 2,500,000 2,000,000 1,500,000 1,000,000 Gross tonnesGross 500,000 0 To and To and To and To and North to North to North to West to South to from from Vales from from Cardiff South West North North Eraring Point Newstan Teralba yards Route
Note 1: Figures for Newstan and West to North include some coal traffic whose ultimate destination is Eraring, because the network configuration means that traffic heading from the south or west into Eraring has to use the Newstan crossings to turn around. Note 2: Data for 2018-19 has been extrapolated to give a full year forecast. Data source: Transport for NSW.
Rate of return and remaining mine life IPART 16
Historically, BlueScope Steel at Port Kembla has purchased small amounts of coking and thermal coal from Hunter Valley mines.29 However, BlueScope currently sources all its coking coal from the Illawarra region.30 Given the rise of renewables, and Some mines in the south-west transport coal along the main line and on to environmental RailCorp’s network to the port at Newcastle. They also use the Newstan loop opposition to new to turn around trains going to the power stations. There is also a small coal mines and amount of coal–related traffic that goes to and from Cardiff rail yards in the north-west.31 carbon emissions, there is uncertainty In 2017-18 and 2018-19, the amount of coal traffic to Eraring and Vales Point about the future of increased, while the proportion of coal traffic from the southern and western coal-fired power mines to Newcastle decreased. Other coal traffic has remained mostly stable, stations beyond in smaller volumes. 2032 3.2.2 There is uncertainty about the future of coal-fired power stations beyond 2032
Since our 2014 review, a number of other coal-fired power stations have publicly announced their intention to close. In 2015 and 2017, AGL announced its intention to close the Liddell Power Station in 2022.32 In November 2014, EnergyAustralia announced it would permanently close the newly acquired Wallerawang power station due to ongoing reduced energy demand, lack of access to competitively priced coal and the power station’s high operating costs.33 Wallerawang power station has subsequently closed.
IBISWorld reports make the following comment about the fossil fuel generation industry: The rising cost efficiency of renewable forms of energy, staunch environmental opposition to new coal mines and regulatory changes regarding carbon emissions are all significant impediments to the industry's growth. Investment in new fossil fuel generation plants has waned over the past five years due to regulatory uncertainty, while most new generation investment has been directed to wind and solar plants. Furthermore, energy usage per capita has fallen over the past decade due to increased energy efficiency of appliances, the uptake of photovoltaic solar panels and other measures, which have reduced long-term demand for fossil fuel generated power.34
29 ACCC, Statement of Issues – South32 – proposed acquisition of Metropolitan, February 2017, p 5. 30 Ibid. 31 Based on the gross tonne weight per train, this does not appear to be coal traffic, but may be coal wagons being serviced at the Cardiff yards. 32 See https://www.agl.com.au/about-agl/how-we-source-energy/agl-macquarie, accessed 2 July 2019. 33 See https://www.energyaustralia.com.au/about-us/energy-generation/wallerawang- power-station-closure, accessed 2 July 2019. 34 IBISWorld, Industry market research, Fossil fuel electricity generation, accessed April 2019.
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We also consulted Origin Energy and Delta Electricity about the economic outlook for Eraring and Vales Point power stations.
Origin intends to be out of coal by 2032
Origin has recently increased its output, but has announced that it will exit coal fired generation by 2032.35 Origin currently uses more than 6 mtpa of coal, up from the 4 mtpa in 2014, reflecting higher production levels to support energy requirements, because of the closure of other power stations.36
Origin currently has a number of short and medium-term contract arrangements with various mines for the supply of coal. Since 2014, it upgraded its rail to 30 tonne axle load and upgraded wagon trains to 120 tonnes and now purchases around 2 mtpa of coal from a number of Hunter Valley coal mines, including those in the lower, and upper Hunter Valley (Zones 1 and 2), as well as domestic coal from mines in the south-west region.37 Origin noted that the future stated closure of Liddell power station could free up further rail capacity and thermal coal supply in the Upper Hunter, although coal from this zone faces a range of logistical issues in supplying Eraring.38
The continuation of the power station would therefore depend on the availability of a buyer and market conditions at the time, including emissions reduction and clean energy policies, as well as the status of the potential SA- NSW transmission interconnector39, which may affect demand for local generation.
Delta Electricity’s effective economic life for Vales Point is 2029
We consulted Delta Electricity about the economic outlook for Vales Point power station. Delta Electricity uses a consistent volume of 3 mtpa of coal, of which two thirds is contracted locally from mines that do not use the RailCorp HVCN. Delta Electricity has contracts with various Hunter Valley mines to supply 1.3 mtpa of coal per annum up to 2022, and often purchases ‘small bites’ of coal (around 500 kt at a time) on the spot market when the price is favourable. Delta Electricity stated that at the end of this contract, it could source up to 50% of its coal either locally or from the Hunter Valley. This could come from a number of mines, including Bengalla, Bulga, Mangoola, Airly and Wallarah 2.40
35 See https://www.originenergy.com.au/blog/big-picture/commitment-renewables-gets-big- boost.html, accessed 2 July 2019. 36 IPART consultation with Origin Energy. 37 Ibid. 38 Ibid. 39 See https://infrastructurepipeline.org/project/sa-to-nsw-high-capacity-interconnector/, accessed 2 July 2019. 40 IPART consultation with Delta Electricity.
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Delta Electricity states that the expected life of Vales Point is 2029, but this would depend on trends in electricity pricing and government policy.41 It is currently investing in capital expenditure on an annual basis for 2029 and potentially beyond.42
3.2.3 Coal revenue is projected to decline over the next five years
IBISWorld states that the coal mining industry is in the mature stage of its economic life cycle and notes that ‘black coal is increasingly being viewed as an outdated and inefficient way to generate electricity due to the associated adverse environmental effects’43. However, it states that global demand for steaming (thermal) and coking coal is likely to strengthen over the next five years, as the Australian dollar remains weak, although Australian producers will be subject to increased competition from global suppliers. Domestic demand is expected to decline over the next five years, as the energy industry moves towards renewable energy alternatives.44
BlueScope Steel has historically purchased coal from the Hunter Valley, but its demand is likely to decline
BlueScope operates the Port Kembla Steelworks in the Illawarra region of NSW. It uses both coking coal and thermal coal in its operations. Historically, BlueScope has sourced small amounts of both coking coal and thermal coal from the Hunter Valley.45 There is a good supply of coking coal in the Illawarra region, and BlueScope has a long-term contract with South32 to supply coking coal until 2032.
In 2018, BlueScope signed a 7-year solar power purchasing contract to underpin a 500,000 panel solar farm in the Riverina district to reduce its rising energy costs. This would supply around 20% of BlueScope’s Port Kembla electricity needs.46 This would be likely to reduce BlueScope’s potential future demand for Hunter Valley thermal coal.
IBISWorld reports the steel manufacturing industry to be in decline. It has benefited recently from decrease in Chinese steel capacity, higher global steel prices and government tax concessions. However, it faces risks in higher energy prices, raw material prices, exchange rate fluctuations and competition from other suppliers and materials in future.47
41 Ibid. 42 Ibid. 43 IBISWorld, Industry market research - Black Coal Mining, accessed 6 June 2019. 44 Ibid. 45 ACCC, Statement of Issues – South32 – proposed acquisition of Metropolitan, February 2017, p 5. 46 BlueScope Steel, BlueScope underwrites investment in 500,000 panel solar farm, Media release, July 2018. 47 IBISWorld, Industry market research – Iron smelting and steel manufacturing, accessed April 2019.
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South-west mines export coal at Newcastle and supply the power stations
Currently, there are a few mines in the south-west, such as Clarence, Springvale and Mandalong that use the line to transport coal to Newcastle, and supply the power stations via the Newstan Colliery loop (for which they pay an access charge to RailCorp). We consider that this is because: Global coal prices have increased: This is due to tighter production regulations in China, which may make it more economic for these mines. Recent industrial action at Port Kembla48: This may have reduced productivity at the port. Price differentials between Port Kembla and Newcastle: Port Kembla has a volume-driven price strategy. However, it has lost some volume from local mines recently, which has increased the cost per tonne for other users.
These are smaller mines, with lower levels of production and comparatively shorter mine lives. They are also price sensitive and ports at Port Kembla or Newcastle are highly substitutable. We consider that in the absence of other users on the line, RailCorp would be unlikely to recover its depreciation costs from these users alone.
3.2.4 The longest-lived substantial mines (LLSM) have an expected life until at least 2044
In our 2014 review, we estimated remaining mine life by: Identifying mines whose annual production was substantial enough to supply the power stations (ie, their annual production was above a minimum threshold) Determining the longest-lived mines by dividing marketable coal reserves by annual production levels.
In this review, we have added a further step, which is to consider the impact of regulatory uncertainty, particularly around investment in fossil fuel, and increased energy efficiency and cost efficiency of renewable energy forms. We have used this information to determine an appropriate balance between reducing the risk of asset stranding and moderating customer price impacts.
For this review, we used a minimum threshold of 3 mtpa, which is what Delta Electricity advised us that Vales Point uses each year. This is slightly lower than our 2014 threshold of 4 mtpa. However, it does not make much
48 Australian Financial Review, 'No joy': BlueScope steelworkers to strike at Port Kembla over pay, January 2019; Illawarra Mercury, Port Kembla Coal Terminal workers to strike after lockout ends, January 2019; Illawarra Mercury, Port Kembla Coal Terminal workers on strike until Monday, February 2019; The Australian, Port Kembla Coal Terminal industrial dispute: union claim win in bitter dispute, April 2019.
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difference to our sample of mines because most mines produce either a substantial amount of coal, or very small amounts.
Marketable reserves and recent production provide the best estimate of mine life
We used 2018 (or most recent) annual production levels as a proxy for expected production levels going forward, and marketable proved plus probable reserves, consistent with our 2014 review. In our 2014 review, we obtained this information from the NSW Coal industry Profile 2013. However, this publication is no longer available. We have relied on various sources, including individual mining websites and annual reports, and submissions to the ACCC in relation to ARTC’s access undertakings.
The ARTC submitted that IPART’s method fails to consider supply side factors such as licence terms and the risk posed by using proved and probable reserves in the mine life calculation. It statesd that ‘the equation assesses Proven and Probable reserves as being equally certain of production, which…ensures that network owners are accepting an element of reserves risk in the [remaining mine life] calculation’49. It also assumes mines continue production until all reserves are depleted notwithstanding the presence of studies which highlight this is not the case’.50
We acknowledge that there is uncertainty in estimating the remaining life of a mine. However, we consider that the use of proved and probable marketable reserves provides the best estimate of useful remaining reserves at this time. Remaining reserves are affected by many factors, including production rates, production technology, maintenance and stoppages, and the discovery of new deposits. Coal mining companies periodically review their reserves in light of these factors. Since our 2014 review, they have changed quite substantially for some of our longest-lived mines, including increases of 71% for Wambo, 68% for Hunter Valley Operations, and 42% for Bengalla.51 By reviewing and updating for these changes every five years, we aim to ensure that any changes to the estimated remaining mine life can be incorporated without large price shocks.
The ARTC also submitted that ‘the assumption of perpetual extension [of licenses] is no longer appropriate, as there is no certainty such extensions will be granted. The assumed life of a mine for regulatory depreciation purposes should therefore be limited to the term of its current license’52.
While there are some risks associated with licence renewal, we do not consider licence term to be a suitable proxy for remaining mine life. Licences are a technical construct that would underestimate the remaining economic life of the mine, based on its proven and probable reserves.
49 ARTC submission to IPART Draft Report, May 2019, p 2. 50 Ibid. 51 IPART, NSW Rail Access Undertaking – Review of the rate of return and remaining mine life, Final Report, p 27. 52 Ibid.
Rate of return and remaining mine life IPART 21
We consider that while the power stations continue to supply baseload generation, their demand would necessitate adequate supply, so long as the mines have adequate reserves to provide this. Limiting the economic life to the term of the licence would have the effect of substantially increasing depreciation and hence, access prices for customers. That, in turn, may reduce traffic on the line and RailCorp’s ability to recover its depreciation expense.
We have not included prospective or non-substantial mines
We have not included prospective mines where we do not have information about their reserves, production levels and commencement dates. Should new mines commence operations or extensions to existing mines be granted, we would consider them at our next review.
As such, we have not included Wallarah 2. While Wallarah 2 received approval in January 2018, its start date is uncertain. Once it commences operations, it is expected to produce around 5 mtpa for 28 years. Likewise, we have not included Watermark, which is still prospective and likely to produce around 3.3 mtpa.
Table 3.1 shows the list of relevant mines and their remaining life.
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Table 3.1 Longest-lived substantial mines (LLSMs) in the HVCN
Name Marketable Production Marketable Estimated Implied coal 2018 (Mt) reserves / remaining terminal reserves at production mine life date 30 June 2018 (Mt) at 30 2018 (Mt) June 2019 (years) Wambo UG 257 5.4 47.4 46 2065 and OC Maules Creek 440 9.7 45.5 45 2064 Hunter Valley 554 12.8 43.3 42 2061 Operations OC Narrabri 222 5.8 38.0 37 2056 Wilpinjong OC 148 5.0 29.6 29 2048 Bengalla OC 187 8.9 21.1 20 2039 Mount Thorley / Warkworth 225 12.0 18.8 18 2037 There are a number OC of mines that could Mt Arthur OC 328 19.0 17.3 16 2035 continue to supply Boggabri 119 7.1 16.7 16 2035 coal up to and Ravensworth Narama & 148 9.5 15.6 15 2034 beyond our North Ulan UG and estimated terminal 140 11.5 12.2 11 2030 date West Bulga OC 90 8.1 11.1 10 2029 Moolarben OC 148 17.6 8.4 7 2026 Mangoola 84 10.6 8.0 7 2026 Mt Owen 51 8.6 5.9 5 2024 Note 1: OC = open cut. UG = underground. Note 2: Production for 2018 may include a combination of forecast and actuals, based on company reports. Source: See Appendix B. IPART calculations.
The longest-lived mine is the Wambo open cut and underground complex, with a terminal date of 2065. Maules Creek and Hunter Valley Operations also have longer expected lives, due to increased estimates of marketable reserves since our 2014 review, and lower than expected production at Maules Creek. Along with Narrabri, the terminal dates for these mines are later than the next LLSMs, which are mostly clustered around terminal dates in the 2030s.
It appears likely that, even with increased output due to high coal prices since 2016, a number of mines could continue to supply coal up to and beyond 2044. However, we consider that the more relevant factor for determining the depreciation rate for RailCorp’s HVCN is how long the power stations would continue to have demand for coal.
Rate of return and remaining mine life IPART 23
South and western coal mines are not likely to be substantial and long-lived
The mines in the south and west that transport coal north via the HVCN include Clarence, Airly, Springvale and Mandalong. Airly is the longest- lived mine in this group with the volume of marketable coal reserves allowing production to continue at current levels for over 30 years (see Table 3.2). It was placed on ‘care and maintenance’ in 2012, but re-opened in 2014 and currently transports a small amount of coal annually - less than 0.9 mtpa. However, Airly is likely to increase output up to 2.0 mtpa in the near future, which would reduce its remaining life.53
Springvale, Clarence and Mandalong have higher levels of annual production, but shorter lives (see Table 3.2).
Table 3.2 Reserves and production of western mines
Name Marketable Production Reserves / Implied end Remaining coal (Mt) production year mine life at reserves (Mt)a 30 June (Mt) at 30 2019 (years) June 2018 Clarence 38 2.5 15 2033 14 Airly 31 0.9 34 2052 33 Mandalong 79 5.6 14 2032 13 Springvale 26 4.4 6 2024 5 Source: See Appendix B. IPART calculations.
While some of these mines supply the power stations, their current production rates and estimated remaining lives suggest that they would not be LLSMs.
3.2.5 Changing the terminal date would have implications for prices
While a number of mines could continue to supply coal to the power stations up to and beyond the current terminal date of 2044, this is likely to be limited by the economic life of the power stations. As such, we have decided to reduce our estimate of the remaining mine life to 2040.
If the power stations were to close before 2044, it is unlikely that the line would be able to recover its full economic costs. Even if there were smaller mines using the line to transport coal to Newcastle, or BlueScope in Port Kembla, the necessary increase in prices to cover return on capital would probably make it uneconomic for those users to continue to use the line.
There may be more certainty when we next undertake this review in 2024. At that stage, we can adjust the estimated remaining mine life and depreciation schedule to reflect the longer or shorter remaining life. However, if we wait
53 IPART consultation with Centennial Coal, June 2019.
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until our next review, in 2024, when there may (or may not) be more certainty about the future of coal-fired generation, we would create substantial price shocks for access seekers if we reduce our terminal date.
Alternatively, reducing our estimate of the remaining mine life now spreads the price increase over a longer period. If we find at the next review that the power stations are likely to continue beyond the terminal date then we can adjust the depreciation schedule at that time.
In making our final decision, given the above uncertainty we have reviewed the price impacts of different options and selected one that provides an appropriate balance between ensuring that our decision does not create stranded assets for RailCorp or unnecessary price impacts for access seekers.
We have reviewed a number of different scenarios (Table 3.3) and calculated the impact on RailCorp’s ceiling prices.
Table 3.3 Different options for terminal dates
Scenario Description Base Maintain the current terminal date of 2044 case Option 1 Bring forward the terminal date to 2032, Origin’s announced exit from coal fired generation Option 2 Bring forward the terminal date to 2036 Option 3 Bring forward the terminal date to 2040 Option 4 In 2024, bring forward the terminal date to 2032 Option 5 In 2024, bring forward the terminal date to 2036 Option 6 In 2024, bring forward the terminal date to 2040
We have used RailCorp’s operating costs from their most recent, published compliance assessment and adjusted the depreciation component, assuming all other costs remain constant.54
The results are shown in Table 3.4.
54 On 16 April 2019, TfNSW submitted overdue compliance statements for 2015-16 to 2017-18 financial years.
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Table 3.4 Impact of a change of terminal date on ceiling prices
Review Terminal Depreciation Total Increase in date date rate depreciation allowed ($2014-15pa) revenue % Base case 2014 2044 3.3% Option 1 2019 2032 7.7% 1,201,112 13.5% Option 2 2019 2036 5.9% 918,497 7.9% Option 3 2019 2040 4.8% 743,546 4.4% Option 4 2024 2032 12.5% 1,951,807 28.3% Option 5 2024 2036 8.3% 1,301,205 15.4% Option 6 2024 2040 6.3% 975,904 9.0% Source: IPART, Compliance with the NSW Rail Access Undertaking 2014-15 – Information Paper, 2017; IPART calculations.
Basing our estimate Reducing our estimate of remaining mine life now would result in an increase of the remaining in RailCorp’s allowed revenue of 4.4% to 13.5%. However, waiting until 2024 mine life on a could result in a much larger increase of 9.0% to 28.3%, because of the shorter terminal date of time period until termination to recover costs. 2040 would result These calculations represent the maximum ceiling revenue that RailCorp in a moderate could recover. According to its most recent compliance statement, RailCorp increase of 4.4% in is recovering more than its full economic costs (ceiling revenue) on the line allowed revenue, and has an over recovery balance in its Unders and Overs account. Railcorp all else constant is required to manage this account so that its balance should not exceed +/- 5% of forecast access revenue. This over recovery amount could be used to offset the impact of the reduction in the terminal date for current access seekers.
On balance, given the price impacts, we consider that basing our estimate of the remaining mine life on a terminal date of 2040 would provide an appropriate balance between reducing the risk of stranding the line and moderating price impacts for access seekers.
Rate of return and remaining mine life IPART 26
4 Reviewing the rail access regime
The NSW Undertaking was drafted in 1999. Since then, there have been changes in the ownership, scope and complexity of the networks covered by the regime. Regulatory practice has also evolved substantially.
This chapter discusses our analysis of issues with the current regime and its interaction with other rail access regimes. We considered matters raised in submissions and from our own experience as the regime regulator.
4.1 We recommend a review of the NSW access The NSW rail regime access regime requires review in Recommendation light of changes in 1 That the NSW Government should ask IPART to undertake a review of the the ownership, NSW Rail Access Undertaking. scope and Based on our experience and submissions from rail infrastructure owners, complexity of the access seekers and other regulators, it is apparent that current access networks it covers, regulation is no longer meeting stakeholder needs. to ensure it meets the needs of We consider that there would be merit in a national review of rail access stakeholders regimes and have made a submission to the Productivity Commission’s Inquiry into National Transport Regulatory Reform to express support for a national review, and request that COAG continue to implement its National Rail Vision and Work Program.
However, as a national review would take some time to commence, we maintain our recommendation for IPART to undertake an independent review of the NSW Rail Access Undertaking. An independent review would ensure that access charges reflect the full economic cost of providing access (but not more), simplify the relationship between the NSW and national access regimes and better meet the needs of access seekers.
In the interim, we will: Explore what information we can publish as part of our compliance reports to assist end use customers to obtain refunds where they have paid more than the full economic costs, and Work with TfNSW to review and update RailCorp’s Unders and Overs policy to improve transparency about how annual price adjustments would be managed.
Rate of return and remaining mine life IPART 27
4.2 The NSW Rail Access Undertaking is not meeting the needs of stakeholders
In our Draft Report, we identified the following concerns with the way the regime is operating: Compliance/enforcement of the regime is inadequate. For some networks, access charges have exceeded the full economic cost of providing access for several years. Currently, the onus is on the access seeker to pursue legal recourse. This has not proved to be an effective means of protecting access seekers from being overcharged.
The relationship between the NSW and federal regimes requires review. Currently rail operators can choose which regime to be regulated under (the NSW regime or the Commonwealth regime administered by the ACCC). This leaves access seekers potentially dealing with multiple regimes. It also allows operators to select regulatory outcomes in order to maximise returns. The current regime is not meeting the needs of access seekers. There appears to be increasing dissatisfaction with the current regime. In June 2018, a group of access seekers obtained authorisation from the ACCC to collectively negotiate non-price terms of access with RailCorp as individual negotiations had failed.55
We recommended that it would be timely for IPART to undertake an independent review of the Undertaking.
4.2.1 Stakeholders strongly supported a review of the regime, and raised a number of concerns with its current operation There was strong support for a There was strong support for a review of the current NSW regime and its review of the NSW interface with other access regimes, with stakeholders raising a number of concerns with its current operation: access regime There is limited guidance to arbitrators on arbitrating an access price between floor and ceiling, which diminishes the efficacy of the negotiate- arbitrate model56, and IPART has limited power to monitor, audit and enforce access provisions57 It is not effective in addressing network interface risks, standards and performance58, and access seekers are the ones who manage the inefficiencies of dealing with multiple regimes59
55 Pacific National submission to IPART Draft Report, May 2019, p 2. 56 Aurizon submission to IPART Draft Report, May 2019, p 2. 57 Pacific National submission to IPART Draft Report, May 2019, p 1. 58 Aurizon submission to IPART Draft Report, May 2019, p 2. 59 Pacific National submission to IPART Draft Report, May 2019, p 1.
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It does not effectively balance commercial outcomes60, and protect access seekers from being overcharged61 It constrains rail operators from modifying their operations to improve productivity and innovation.62
The ARTC noted that a number of other jurisdictions were undertaking reviews of state-based access regulation, including the: Queensland Competition Authority review of its Declaration of Rail Assets WA Treasury review of the WA Rail Access Regime, and Essential Services Commission of South Australia’s draft guidelines on the rail guidelines for the Tarcoola to Darwin railway.63
Many of these access problems extend beyond the NSW regime and require consideration of the interface between regimes
While stakeholders supported an IPART review of the NSW Undertaking, they noted that many issues were a function of inconsistency between regulatory models64. Aurizon recommended that IPART make a submission to the Productivity Commission’s Inquiry into Transport Regulation with respect to the productivity and consistency benefits that could be released from harmonisation and consistency in rail access regulation.65 Pacific National stated that …’two access regimes regulate the Hunter Valley coal network creating unnecessary duplication of regulatory effort and the potential for interface problems…’.66
The ARTC stated that it would ‘…strongly support an enquiry by the [Productivity Commission] of greater national integration of rail economic regulation, which would incorporate the proposed [NSW Rail Access Undertaking] review and provide greater integration benefits to the rail industry than a further (isolated) review of a state specific regulatory instrument’.67
We would support a national review of rail access regulation
We acknowledge stakeholders’ concerns that many of these issues relate to regulatory duplication, uncertainty, and interface issues between regimes that a state-based review may not wholly address. We would support a national review of rail access regulation should the Australian Government commission one.
60 Aurizon submission to IPART Draft Report, May 2019, p 2. 61 Pacific National submission to IPART Draft Report, May 2019, p 1. 62 Aurizon submission to IPART Draft Report, May 2019, p 2. 63 ARTC submission to IPART Draft Report, May 2019, p 3. 64 Aurizon submission to IPART Draft Report, May 2019, p 3. 65 Ibid. 66 Pacific National submission to IPART Draft Report, May 2019, p 2. 67 ARTC submission to IPART Draft Report, May 2019, p 2.
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We note that COAG’s Transport and Infrastructure Council included in their National Rail Vision and Work Program that, among other things, they would: Review the different rail access regimes and charges calculation methods by the end of 2016. Review the costs and benefits of having multiple access regimes for rail We would support operators and customers by early 2017. a national review of Develop possible options for a national/harmonised rail access regime by access regulation, the end of 2017, including assessment of possible approaches against mechanisms proposed for road pricing and against national competition and have written to policy.68 the Productivity Commission to However, this does not appear to have happened. In 2018, the Department recommend one of Infrastructure, Regional Development and Cities (DIRDC) engaged PwC Consulting to look at specific aspects of the current rail access regimes in each jurisdiction.69 However, while this is a useful document, it does not advance the issues.
We have made a submission to the Productivity Commission’s Inquiry into National Transport Regulatory Reform to: Suggest that it may be timely for the Australian Government to reconsider whether the current rail access regimes are working effectively together Encourage COAG to continue to implement its National Rail Vision and Work Program Express our support for a national review of rail access regulation.
However, we note that it would take some time for a national review to be organised. In the meantime, we maintain our recommendation that IPART conduct a review of the NSW undertaking. Our review could address state- specific issues and make recommendations that feed into a national review.
Regulatory overlap may reduce efficacy of the rail access regimes
Currently, rail infrastructure owners in NSW can choose to give voluntary written undertakings to the ACCC and be subject to the national access regime. Otherwise, they fall under the NSW Undertaking.
As a consequence, the ACCC submitted that this has led to rail infrastructure owners having the incentive and ability to switch and choose between Commonwealth or NSW regulation, depending on which regulatory framework is likely to provide a better outcome at a given time.70 The ACCC
68 Transport and Infrastructure Council, National Rail Vision and Work Program, p 5. 69 Department of Infrastructure, Regional Development and Cities PwC, Rail Access Regimes, May 2018. 70 ACCC submission to IPART Draft Report, May 2019, p 2
Rate of return and remaining mine life IPART 30
also stated that there have been instances where industry has traded-off regulatory certainty for less favourable access terms and conditions.71.
While a review of the NSW undertaking would not address the issue of overlapping regimes, it would identify any outdated provisions in the NSW regime, and ensure it remains fit for purpose in light of changes in economic and industry conditions since 1999.
We considered whether changes to the Transport Administration Act 1988 could discourage regime switching, but decided this should form part of our review
Given that a review of the Undertaking would be a longer-term solution, we considered whether the government could make minor changes to the provisions of the Transport Administration Act 1988 (TAA) that govern access undertakings to provide greater regulatory certainty in the interim.
Section 99C(2) of the NSW Transport Administration Act 1988 (TAA) states that such an undertaking may be made, withdrawn or varied with the approval of the Minister and concurrence of the Premier. However, the ARTC is explicitly exempt from this provision.
We considered whether removing this exemption would set a higher bar for the rail infrastructure owner to switch between regimes. However, we consider that any changes to the legislation should be looked at and consulted on as part of a broader review.
4.3 We will provide more information in our compliance reports Increased transparency in Stakeholders’ raised concerns that access charges have exceeded full calculating and economic costs in recent times, and the current regulatory regime has not refunding any proved effective in protecting access seekers from being overcharged.72 overcharges would The rail operator (access seeker) has limited incentives to approach the rail be an effective infrastructure owner for a refund of any over-recovery of access charges, interim measure for because it generally passes through access costs in full to its customers. The access seekers rail infrastructure owner has no incentive to provide information about access charge over-recovery to end use customers (mine owners), because it has no commercial agreement with them, only the rail operator. While end use customers could negotiate their own access contracts with the rail infrastructure owner, there are additional overhead costs associated with this.
Each year we assess RailCorp’s compliance with the Asset Valuation Roll Forward Principles and determine whether they have complied with the
71 ACCC submission to IPART Draft Report, May 2019, p 3. 72 Pacific National submission to IPART Draft Report, May 2019, p 1.
Rate of return and remaining mine life IPART 31
Ceiling Test having regard to the operation of the Unders and Overs Account. We consult on RailCorp’s compliance proposal, and our Draft Decision, before publishing a Final Decision. In previous decisions we have published information on the closing RAB and full economic costs of the sectors and compared this to access revenue received on an annual basis.
We will explore what information we can publish as part of our compliance assessment reports to assist end use customers to obtain refunds where they have paid more than the full economic costs. We are currently assessing RailCorp’s compliance for the 2015-16 to 2017-18 financial years and will consult on specific measures as part of our draft decisions on RailCorp’s compliance, which we expect to release later in July 2019.
We will also work with Transport for NSW to review and update RailCorp’s Unders and Overs policy, which would assist in promoting transparency about how annual price adjustments would be managed. Railcorp is required to manage this account so that its balance should not exceed +/-5% of forecast access revenue. The policy should outline how any over-recovery would be refunded or used to offset access prices for access seekers.
Rate of return and remaining mine life IPART 32
Appendices
Rate of return and remaining mine life IPART 33
A Proxy company selection and beta estimation
The industry of the benchmark efficient firm is a proxy for the risk profile of that firm. That is, all firms within a common industry group face the same or similar business risks. To determine a list of proxy firms, we searched for firms in the Thomson Reuters Datastream that: Operate in the nominated industry (in this case, ‘Industrial transportation – Railroads’) Undertake their activities in markets that are sufficiently similar to Australia.
We then considered whether the firm’s sovereign government bond and equity markets were sufficiently deep and liquid. This excluded some firms operating in China, Russia and some African companies.
We further excluded: Firms that are no longer trading Thinly traded stocks, as these could produce distorted estimates due to stale price data Firms that don’t earn revenue predominantly in the nominated industry (most of our comparators are diversified and have several business segments, which span different activities in transport logistics and services).
Our list of proxy firms resulted in 10, mainly US and Canadian firms which own and operate railway infrastructure as their primary business activity.
The modelled beta estimate (levered beta) incorporates financial leverage which can affect a company’s performance. Higher levels of debt tend to increase the volatility of a firm’s stock price and therefore influence its beta. This variability reflects financing decisions rather than any fundamental difference in operational risk. For this reason, the estimate is unlevered to generate an asset beta which reflects a capital structure with no debt. This asset beta is then relevered using the benchmark firms gearing ratio and corporate tax rate.
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Analysis using a broader set of comparable firms
We consider three broader proxy industries could include: coal mining, coal-fired electricity generation, and a broader set of rail transport businesses.
We examined two time periods: January 2003 to April 2019 (representing the longest available time series) and April 2016 to April 2019 (representing the most recent three year period). For the longer period, there were 21 coal mining firms, 40 electricity generation firms and 74 rail transport firms with sufficient data. For the shorter, more recent period, there were 7 coal mining firms, 18 electricity generation firms and 52 rail transport firms with sufficient data.
We are presently consulting on our automated method of performing proxy company analysis to determine equity beta and target gearing for a Benchmark Efficient Entity.
https://www.ipart.nsw.gov.au/files/sharedassets/website/share d-files/investigation-administrative-legislative-requirements-sea- wacc-methodology-2017/fact-sheet-estimate-equity-beta-1-april- 2019.pdf
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B Mine reserves and production sources
Table B.1 Mine data sources
Mine name Majority Reserve source Production source shareholder Hunter Valley Operations OC Yancoal/Glencore Yancoal, Global offering Volume 1, November 2018, p 8. Yancoal, Global offering Volume 1, November 2018, p 8. Maules Creek Whitehaven Whitehaven Coal, Annual Report 2018, p 55. Whitehaven Coal, Annual Report 2018, p 33. Narrabri Whitehaven Whitehaven Coal, Annual Report 2018, p 55. Whitehaven Coal, Annual Report 2018, p 33. Ravensworth Narama & North Glencore Glencore, Resources and Reserves as at 31 December Glencore, Ravensworth Open Cut Annual 2018, p 48. Review 2017, December 2017, p 32. Bulga OC / Blakefield South UG Glencore Glencore, Resources and Reserves as at 31 December Glencore, Bulga Coal 2018 Annual Review, 2018, p 48. March 2019, p 16. Mount Thorley / Warkworth OC New Hope Yancoal, Global offering Volume 1, November 2018, p 8. Yancoal, Global offering Volume 1, November 2018, p 8. Bengalla OC New Hope Group New Hope Group, Annual Report 2018, p 14. Hansen Bailey, Bengalla Annual Review 2017, p 16. Mt Arthur OC BHP BHP, Annual report 2018, p 268. BHP, Mt Arthur Coal Annual Environmental Management Review FY18, p 13. Moolarben OC Moolarben Coal Yancoal, Global offering Volume 1, November 2018, p 8. Yancoal, Global offering Volume 1, November 2018, p 8. Wambo UG and OC Peabody Energy Peabody, Wambo Coal Mining Operations Plan 2018 - Peabody, Wambo Coal Pty Limited 2020, December 2017, p 5. 2017 Annual Review, March 2018, p 11. Boggabri Idemitsu Castalia Strategic Advisors, Mine Life Analysis Data and Idemitsu, Boggabri Coal Mine Methodology, August 2016, p 7. 2017 Annual Review, March 2018, p 19.
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Mine name Majority Reserve source Production source shareholder Ulan UG Glencore Glencore, Resources and Reserves as at 31 December Glencore, Ulan Complex Annual Review 2017, 2018, p 48. June 2018, p 19. Wilpinjong OC Peabody Energy Peabody, Wilpinjong Coal Project Open Cut Operations Peabody, 2017 Annual Review Wilpinjong Coal Mining Operations Plan 2017 – 2019, June 2017, p 21. Mine, December 2017, p 10. Mt Owen Glencore Glencore, Resources and Reserves as at 31 December Glencore, Mt Owen Complex 2018, p 48. Annual Review 2018, March 2019, p 28. Mandalong Centennial Centennial Coal, Statement of Resources and Centennial Coal, Mandalong Mine Annual Reserves as at 31 December 2015, p 1. Review, March 2018, p 18.
Mangoola Glencore Glencore, Resources and Reserves as at 31 December Glencore, Mangoola Open Cut Annual Review, 2018, p 48. March 2019, p 12. Newstan Centennial Centennial Coal, Statement of Resources and Centennial Coal, Newstan Colliery Annual Reserves as at 31 December 2015, p 1.nd Review, March 2018, p 9. Reserves as at 31 December 2015
Clarence Centennial Centennial Coal, Statement of Resources and Reserves Centennial Coal, Clarence Colliery Annual as at 31 December 2015, p 1.nd Review, March 2018, p 22. Airly Centennial Centennial Coal, Statement of Resources and Reserves Centennial Coal, Airly Colliery Annual Review as at 31 December 2015, p 1.nd 2017, May 2018, p 19. Springvale Centennial Centennial Coal, Statement of Resources and Reserves Centennial Coal, Springvale Colliery Annual as at 31 December 2015, p 1.and Review 2017, March 2018, p 25. Wallarah 2 Kores n/a http://www.wallarah.com.au/project-description Watermark Shenhua Watermark n/a http://www.shenhuawatermark.com/shaus/13827 05825865/The_Project.shtml
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